The Department of Labor issued a proposal on Tuesday for its long-awaited fiduciary rule. The proposal provides that “any individual receiving compensation for providing advice that is individualized or specifically directed to a particular plan sponsor (e.g., an employer with a retirement plan), plan participant, or IRA owner for consideration in making a retirement investment decision is a fiduciary.” The DOL suggested that the new standard is necessary because the current definition of fiduciary was adopted in 1975 – before the advent of 401(k) plans, and prior to the rise in popularity of IRAs and rollovers from fiduciary plans to IRAs. According to the DOL, the five-part test enacted in 1975 “allows advisers, brokers, consultants and valuation firms to play a central role in shaping plan and IRA investments without ensuring the accountability that Congress intended for persons having such influence and responsibility.” The current proposal also withdraws the fiduciary proposal issued by the DOL in 2010 (which generated a large number of critical comments).
The definition of “investment advice” in the proposal includes recommendations to distribute plan assets, recommendations as to the management of plan investments, appraisals, and recommendations of a person to provide investment advice or management services. Absent a carve-out (detailed below), a person providing investment advice for compensation (direct or indirect) would be covered by the rule if either the person represents or acknowledges that he or she is acting as a fiduciary, or provides advice “pursuant to a written or verbal agreement, arrangement or understanding that the advice is individualized to, or that such advice is specifically directed to, the advice recipient for consideration in making investment or management decisions with respect to securities or other property of the plan or IRA.” This “functional test” would replace the 1975 five-part test, and represents a departure from the 2010 proposal that included any “investment adviser” under securities laws as a de facto adviser for the purposes of the rule.
The proposal also provides several carve-outs to the definition, including general education, advice provided by employees of the plan sponsor, and marketing or providing a platform of investments for selection by a plan fiduciary, to name a few. The proposal also clarified that attorneys, accountants, and actuaries would not be considered fiduciaries for performing professional assistance in connection with an investment transaction unless they were to step outside of their “normal roles” and recommend specific investments. Under the rule “order-taking” would not be considered “investment advice,” but a worker at a call center could be considered to give advice, depending on the details of the conversation, according to the release.
As part of the discussion in the current proposal, the DOL attempts to quantify the potential costs of conflicts of interest that could be reduced by the rule. According to the DOL, “[a] wide body of economic evidence supports a finding that the impact of these conflicts of interest on retirement investment outcomes is large and, from the perspective of advice recipients, negative.” The DOL asserted that conflicts could cost IRA investors 100 basis of underperformance per year over 20 years. Using the mutual fund industry as an example, the release puts these conflicts in dollar terms, stating that they could cost IRA investors more than $210 billion over the next 10 years and nearly $500 billion over the next 20 years. According to other studies cited by the DOL, these conflicts could cost investors even more – up to 200 basis points of underperformance a year.
In response to criticism from commenters to the 2010 proposal, the DOL attempts to quantify the benefits of the proposed standard. The proposal uses broker incentives through front-end loads to illustrate the retirement account underperformance that the rule is designed to address. According to the DOL, “the proposal would deliver to IRA investors gains of between $40 billion and $44 billion over 10 years and between $88 billion and $100 billion over 20 years.” While the DOL acknowledges that a 100% effectiveness rate for the rule may not be achieved, it nevertheless maintains that the benefits would still exceed the costs of the rule. The proposal states that “if only 75 percent of anticipated gains were realized, the quantified subset of such gains – specific to the front-load mutual fund segment of the IRA market – would amount to between $30 billion and $33 billion over 10 years. If only 50 percent were realized, this subset of expected gains would total between $20 billion and $22 billion over 10 years, or several times the proposal’s estimated compliance cost of $2.4 billion to 5.7 billion over the same 10 years.”
The proposal includes a “Best Interest Contract Exemption” that would continue to allow “[c]ertain types of fees and compensation common in the retail market, such as brokerage or insurance commissions, 12b-1 fees and revenue sharing payments” that would otherwise be prohibited. The exemption would require “the firm and the adviser to contractually acknowledge fiduciary status, commit to adhere to basic standards of impartial conduct, adopt policies and procedures reasonably designed to minimize the harmful impact of conflicts of interest, and disclose basic information on their conflicts of interest and on the cost of their advice.” This provision allows IRA holders “a contract-based claim to hold their fiduciary advisers accountable if they violate these basic obligations of prudence and loyalty.” The proposal would also require certain fiduciaries to comply with the impartial conduct standards of the Best Interest Contract Exemption in conjunction with certain transactions of mutual fund shares. The DOL claims that this exemption stands in contrast to regulatory regimes in places such as the United Kingdom and Australia and “gives firms the flexibility to figure out how to structure their business in order to provide quality advice that is in their clients' best interest.”
The DOL is additionally requesting comment on whether it should provide a streamlined exemption subject to fewer conditions for advisers receiving compensation when recommending “certain high-quality, low-fee investments.” However, while the proposal requested comments on the topic, it refrained from providing additional detail for such an exemption “due to the difficulty in operationalizing this concept.”
The proposal addresses the DOL’s coordination with other agencies such as the SEC and CFTC on the proposal and suggests that the proposal “works in harmony” with the securities laws. The DOL also defended the agency’s decision to move forward alone, arguing that “[e]ven if each of the relevant agencies were to adopt an identical definition of ‘fiduciary’, the legal consequences of the fiduciary designation would vary between agencies because of differences in the specific duties and remedies established by the different federal laws at issue.”
In conjunction with the proposal, the DOL released a page aimed at investors titled “Are Your Retirement Savings at Risk?,” that requests that individual investors share their retirement savings stories. A fact sheet on the proposal can be found here and the DOL’s landing page for the full proposal can be found here along with various resources such as an FAQ.